Buy Low Sell
High. These four simple words summarize millennia of financial
truth. They are the pinnacle of wisdom of virtually infinite
amounts of data and knowledge collectively gleaned on markets by
humankind all throughout our history. They are the great “secret”
of multiplying the assets to which we have been entrusted in the
global marketplace. They impart a timeless truth so simple and
profound that a child can understand it, yet from many sad
historical episodes we know that most adults forget these words
every few generations and get ensnared in a supercycle speculative
mania.

Buying low and
selling high sounds so simple. This timeless truth is implemented
in different ways by different investment philosophies but the end
goal is always the same… to multiply one’s assets. At the most
basic and macro level, there are two camps of investors… the
conventional investor and the contrarian investor.

Conventional
investors are easy to find. They are everywhere. Conventional
investors tend to follow trends and move with the herd, and are only
comfortable throwing their capital at a market once it has already
rallied substantially. This philosophy is also known as momentum
investing. A conventional investor looks for last quarter’s or last
year’s hot sector or stocks, and then reasons, “Well, this sector is
hot and doing great so it will probably continue to do well into the
future”, a linear assumption. Conventional investors are generally
not concerned about archaic concepts such as valuation and price, as
they focus on the boundless opportunities always presented by the
future.

By their very
nature, conventional investors tend to be followers, not leaders.
They want evidence that a bull trend is already well established
before they commit any capital. If an investment is over-priced
relative to the cashflow it can spin-off for its owners, that is not
a problem, as the conventional investor is a hardcore optimist and
always assumes that it will be worth more in the future.
Conventional investors usually end up buying “high” based on
historical fundamentals and hoping to sell “higher” in the future.
Taken to its logical extreme, history has amusingly labeled this
investment philosophy “the greater fool theory”. The general idea
is price and value don’t matter at the time of purchase because one
can always find a “greater fool” to sell to at a higher price
sometime in the undefined future.

In contrast to the
legions of conventional investors galloping through the world
markets, there is a relatively small group of investors known as
contrarians. Contrarians are the black sheep who move “contrary” to
the crowd and conventional market fashions. Contrarians seek to
really literally implement the “buy low sell high” market wisdom.
Contrarians want to buy when investments are cheap from a
fundamental perspective. Of course, usually the only time
investments are fundamentally cheap is when most investors have
totally deserted and rejected a fire-bombed sector of the market.
It takes a great deal of courage to be buying when “conventional
wisdom” says a particular sector or market is doomed.

Contrarians seek
to sell when markets reach mania proportions. When the general
investing public grows really excited and frenzied about a
particular sector or market, chances are it is near its top and the
contrarians have already sold, realizing massive profits.

Contrarians are
often dedicated students of financial market history. They realize
that “new eras” happen over and over and over again, seducing the
naive to their doom. Contrarians also believe that markets are
cyclical and no trend runs forever. Markets become loved and wanted
and they get overvalued. When fundamentals reach mania extreme
levels, the markets are sold hard and they collapse. After the
collapse, valuations are lower than normal as no one wants to jump
back into the market in which many were just burned. Contrarians
believe that the accumulated wisdom of all human financial market
experience in history is more relevant than the lofty claims and
hype of any one particular era.

Interestingly, in
endless prominent academic studies of financial market history, the
only investors who virtually always make money are the contrarians.
Since the contrarians truly “buy low”, when no one else wants an
investment, it is hard to lose capital. Since the contrarians “sell
high”, they are almost always out in the early stages of a mania
before a speculative bubble bursts. Conventional investors on the
other hand, according to voluminous historical evidence, tend to buy
very late in a bull market and then hold onto their investments
through the burst and most of the way down to the ultimate bear
market bottom in the bust.

While the general
investing public is not usually familiar with the contrarian
investment philosophy, they are familiar with its adherents. If one
was to assemble a list of the ten greatest investors and speculators
of our era, the list would probably be almost exclusively
contrarians. The most famous contrarian alive today, and one of the
wealthiest men on the planet because he learned how to practically
implement “buy low sell high” is the legendary Warren Buffet.
Interestingly, if one goes back through market histories of all the
western nations, the names remembered by the history books are
always the contrarians, those brave souls audacious enough to ignore
the crowd and buy and sell based on fundamentals alone.

In the 1970s one
could have made immense profits by buying up gold and commodity
related stocks and ultimately selling when commodities went
parabolic in the late 1970s. Realized gains of far more than 100
times one’s initial investment abounded for those who bought the
last commodities boom near the bottom and sold near the top.

In the 1980s the
legendary returns of the decade were found in equities, primarily
consumer stocks. Some of the best performers of the decade included
Circuit City, Home Depot, Wal-Mart, and Hasbro. Of course, to buy
in near the bottom in 1982 an investor had to have great courage and
HAD to be a contrarian, because the stock markets were universally
hated and loathed in the early 1980s. At that time, the general
public was enamored with commodities such as gold that had already
topped. It took a special breed of investor to jump into equity
markets when newsmagazines were widely heralding “the death of
stocks”.

In the 1990s the
ultimate place to park capital was technology stocks. The leaders
of the last ten years are well known today. They include Dell,
Cisco, America Online, and CMGI. All of these stocks exhibited
trough to peak gains of over a mind-boggling 60,000%. Everyone
today is well aware of the monumental extremes of the final gasps
for breath of the tech bubble as it topped, but it took great
courage to buy virtually unknown tech stocks back in the early
1990s. The US economy was in a recession, Papa Bush was busy
raising taxes and bombing Iraq, oil was spiking, and the equity
markets were still uneasy over the dramatic 1987 correction.

Most tech stock
investors did not jump on the bandwagon until VERY late in the great
tech bull, 1998 to early 2000. It took even more courage to sell
the mania in early 2000, and longtime contrarian investors and fund
managers who sold in late 1999 or early 2000 BEFORE the burst were
often ridiculed and made fun of in the financial press.
Conventional investors claimed the contrarians who sold the mania
just “did not get it” and “do not understand we ARE in a new era”.
Of course, one short year later we look back at the attacks on
contrarians and chuckle, as the ones who sold extreme overvaluation
in NASDAQ tech stocks were the smart ones and now EVERYONE wishes
they had sold the tech mania when it went parabolic in early 2000.

The critical
question for all investors today is… WHERE will the next boom be?
In 2010, when we look back on the “double O’s”, where will we all
wish we had deployed capital to reap the bountiful harvests of the
great bull market of the decade? The investors fortunate enough to
answer this question correctly today will have hundreds or thousands
of times as much real capital in ten years as they have today…
king’s ransoms will be won by the folks on the right side of this
macro trade.

From where is the
next mega-bull going to emerge and stampede to undreamed of heights
in the coming decade? We believe there is a very high probability
that the answer is COMMODITIES.

Commodities?!?!
you say? But no one invests in commodities anymore! But
commodities have declined in price for decades! But commodities are
abundant and cheap! But commodities are so old-fashioned in our
high technology world! But commodities are dead! But! But! But!

But exactly.
Commodities are hated and loathed right now by conventional
investors. Commodities are out of favor. Commodities are not
sexy. Commodities are not lusted after at the moment. Capital has
abandoned commodities. It is enough to warm the contrarian heart!

The all-important
philosophy to remember for truly stellar investing, as everyone
instinctively knows, is “buy low sell high”. Warren Buffet
delightfully fleshes this out in his timeless market quote, “Be
brave when others are afraid and afraid when others are brave.”
Where are the vast majority of investors afraid of investing right
now? Commodities.

You can execute your own quick and dirty empirical study on this
assertion. Turn on bubblevision or a financial news program and
record the amount of time spent discussing equities and tech stocks
in particular. Compare this with the amount of time spent
discussing commodities. Next do a web search for “investing”. For
every Internet destination you are able to find for commodities
investing, you will probably first have to slog through 10,000 on
tech stock investing.

NO ONE can deny
the fact that commodities are terribly out of favor right now, that
the hearts and minds of the thundering herds of investing masses are
still lusting after the tech stocks of old, yesterday’s game. The
contrarians are looking out over the horizon, hand to their brow,
trying to determine where capital will flow in the future, the next
investing Great Game, not where speculative capital has sloshed in
the past.

Of course, our
assertions that commodities are cheap and unloved are meaningless
without data to back them up. We ALWAYS encourage our clients and
friends to do their own due diligence, to investigate themselves,
and to not take our words (or anyone’s) for it. We encourage you to
do the same. Do your own research. Do NOT believe some analyst
just because she is on bubblevision or just because he writes a
newsletter. Study history, study markets, study valuation, study
supply and demand fundamentals, and then draw your own conclusions.

In order to gather
tangible evidence that commodities are indeed undervalued and near a
long-term bottom, there is no better place to start than the
important Commodities Research Bureau Commodities Index.

The CRB index is
without a doubt the most widely followed basket of commodities in
the United States, and probably in the world. The CRB index was
created in 1957 and currently contains 17 commodities, which we call
the CRB 17. There are probably hundreds of other major commodities
traded around the world, but the CRB 17 are generally representative
of the whole commodities market. Just as the NASDAQ composite index
is the most popular index to quickly measure the general health of
the tech stock sector, the CRB index is the tool of choice to
quickly glean the general level of commodity prices. When you ask a
professional about general commodity price levels, they will
inevitably mention the current state of the CRB index.

We are indebted to
our contrarian value-oriented commodity investing friends at the Di
Tomasso Group (www.ditomassogroup.com)
for undertaking an utterly fascinating and tremendously important
historical study of the CRB 17. They took the CRB 17 commodities
and analyzed their individual price levels since 1921. They then
created a hypothetical CRB index made up of the 17 commodities going
back in time well before the official CRB index was born in 1957.
Finally, they adjusted the CRB for inflation over the last 80 years
yielding a constant real average commodity price level of the CRB 17
commodities basket.

The following
graph is a summary of the fruit of Di Tomasso’s research labors. It
shows the general real commodity price level from 1921 to today,
with 1.0 on the graph equaling 1921 price levels. Please study this
graph carefully.

In
inflation-adjusted terms, the CRB 17 commodities, which represent
the commodities markets as a whole, are near ALL-TIME lows!
Remember the pinnacle of market wisdom, buy low sell high?
Investing in commodities today in 2001 near an 80 year real low is
certainly likely to be a near a major bottom! Since 1921, at least,
there has never been a better buying opportunity in terms of the CRB
17 commodity basket.

Another critical
point to note in addition to the absolute low of current real
commodity price levels is the perpetually cyclical nature of the
commodity markets. Observe the two great macro rallies in
commodities of the last 80 years, denoted by the curved red lines.
The first great commodities boom in the graph roared heavenwards
shortly after the massive speculative equity bubble of 1929
imploded. In the brutal investing environment between the great
1929 crash and World War 2, commodities witnessed spectacular gains.

Hmmmm… is it just
us or is anyone else detecting some deja vu here? A massive
speculative equity bubble is bred, and commodities are sold off to
major lows as the equity bubble grows and bursts, leaving its grisly
aftermath. From the ashes of the stock market carnage, investors,
once blinded by lust for the hot sector that led the bubble mania
charge, realize that other crucial areas for the well-being of the
economy were neglected as capital chased the popular bubble
sectors. They realize that prices of commodities are WAY too low,
often below the cost of production, and that commodity production
and distribution infrastructure is falling apart because it couldn’t
attract capital during the equity boom. Investors, only contrarians
at first, begin to realize that human beings NEED commodities to
survive and thrive, and that a decade or two of underinvestment HAS
to be remedied to take the overall economy, which is highly
commodity dependent, to the next level. This 1929 bubble burst to a
mega-commodity rally scenario sounds eerily familiar TODAY, for some
odd reason, but we just … can’t … quite … place … it.

Although most of
us were merely children or a gleam in our father’s or grandfather’s
eye during the first macro commodities rally of the last 80 years,
virtually every long-time investor trading the markets today
remembers the second spectacular commodities rally very well. The
1970s.

In the wild and
crazy years of the 1970s, equity markets breached terrible bear
market lows. OPEC nations had their act together and were agreeing
to limit production of oil, inflation was raging as the money supply
grew at previously unimaginable rates following the US default on
the gold dollar, the Islamic world was trying to invade and destroy
the tiny nation of Israel yet again for the third time, and
commodity infrastructure had been ignored during the go-go stock
market days of the mid to late 1960s. In this environment, which
also sounds eerily familiar, commodities exploded in the 1970s.

While the
aggregate CRB more than doubled in inflation-adjusted real terms as
the graph above shows, individual commodities showed much larger
gains and commodity related equities showed staggering gains, in
some cases exceeding 100-fold runups in price. The only folks who
realized these full gains, however, as usual, were the fearless
contrarians.

It took a
non-conventional investor to sell equities in the late 1960s when
the stock market was doing really well. It took great courage to
buy into commodities in the early 1970s, well before the average
investor realized where the speculative money was going to slosh to
next. It took even greater foresight and wisdom to sell into the
resulting frothy commodity superbull of the late 1970s to realize
legendary profits.

With our strategic
historical perspective on the CRB, and there is no arguing
commodities are now out of favor and prices are dismal in the
aggregate, let’s drill down and look at the CRB 17 from a more
tactical 10 year perspective. The CRB 17 commodities are equally
weighted in the CRB index, and broadly divided into Metals,
Tropicals, Grains, Meat, and Energy. The following graphs show
inflation-adjusted real charts of each individual CRB 17 commodity
from 1990 to the present. Prices are all in constant 2001 dollars.

Looking at
decade-long price charts of CRB metals, it is obvious they have all
been hammered in the 1990s. Even platinum, which has witnessed an
awesome early-stage rally in the last year and a half or so is still
far below its 1990 levels. Gold, of course, is widely believed to be
artificially suppressed by a few western governments and central
banks, for self-serving reasons, and is likely to explode at any
moment.

The important
strategic information to glean from all these CRB 17 graphs
presented together in terms of this essay, however, is to REALIZE
that commodities have been mercilessly pummeled in the 1990s. Many
are at or near all time real lows, and many are at or near their
cost of production. From a macro-contrarian perspective, is now the
time to buy or sell commodities in general? Is this a classic “buy
low” strategic investment play?

The CRB tropicals
have also been roughed up pretty viciously in recent years. Notice
all the trends, whether decade or several year trends, are DOWN,
marked by the red arrows. Orange juice, which is not shown here, is
the fifth CRB tropical commodity, and its chart is shown below in a
subsequent graph.

In the Great
Plains of the United States, where I hail from, the commodity
markets have been extremely hard on those unbreakable men and women
trying to scrape out a living by feeding America and the world.
Wheat, corn, and soybeans, the CRB grains, are doing horribly, and
are at major real lows. Cattle, one of the two CRB meats (hogs are
graphed below), while rallying recently, remain near real lows. If
anyone thinks crucial foodstuff commodities are not important to our
modern world and its ever-ballooning population, try fasting for 40
days and see if your opinion changes. Agricultural commodity prices
at or below their cost of production for most farmers and ranchers
are NOT sustainable and will be forced to move up by irresistible
free market supply and demand forces.

Moving on to the
CRB energies, we finally see some positive commodity developments.
Natural gas rocketed to an all-time real and nominal high last
autumn, and after its parabolic spike it has fallen and currently is
fairly stable at levels two and half times as high as recent
historical norms.

This positive
natural gas chart is actually really illustrative of commodity
cycles in general. Since natural gas was dirt-cheap for so many
years, producers were not encouraged to develop new supplies. Many
oil drilling operations simply burned natural gas in great flares to
get rid of it, and some used injection wells to store “waste”
natural gas underground. Because natural gas prices had been low
for years, natural gas consumers simply assumed that supplies were
abundant and the status quo would remain forever. Electric
utilities, forced by rabid environmentalists to shy away from
nuclear or coal power, migrated en masse to clean, cheap natural
gas.

With very low gas
prices, gradually consumers increased their demand tremendously
while capital invested in new production and distribution waned.
Since there were minimal profits in cheap gas, capital went
elsewhere and the gas market stagnated. All the while, like a
ticking time bomb, demand was growing and growing. Finally, in
2000, there was not enough natural gas to go around, yet electric
utilities and consumers alike demanded huge quantities of it.

The only solution,
so elegantly described by Adam Smith two centuries ago, was the
“invisible hand” of free markets had to push up the price of natural
gas high enough so supply would meet demand. Higher prices attack
supply/demand imbalances simultaneously on two fronts. First,
higher prices retard general demand for a commodity. Second, higher
prices entice out new production which increases supply. The net
effect is a higher, stabilized commodity price at a new higher
market clearing equilibrium price point.

The recent natural
gas rally is a textbook example of how things usually work in
commodities. There is over-investment during the boom phase (the
1970s for many commodities), and eventually much excess productive
capacity comes online which floods the markets with supply and
causes the bust, and prices plummet (1980). With low prices, few
new production or distribution systems are built and gradually
demand grows large enough to eclipse current supplies and fully
utilize the now decaying infrastructure laid in during the earlier
boom phase, and the commodity price is forced up as demand exceeds
supply (the 2000s). A new boom occurs, culminating in a speculative
commodity bubble (2010?), and the cycle begins anew like a phoenix
rising from its ashes.

Jumping back to
the graph above, heating oil has also seen recent rallies, but it is
nowhere near real highs. The CRB tropical orange juice is having a
tough time, as well as the “other white” CRB meat, pork. Of course,
that may be because who wants to eat a pig when they can score a
mouth-watering, exquisite, corn-fed beef filet mignon steak? Yummmm!

The final CRB 17
commodity is also a CRB energy, the ubiquitous crude oil, arguably
the single most important commodity for the complex interconnected
world economy today.

Now we all know
from watching the news that oil is expensive, right? Wrong. In
real terms, oil is still hovering around 1990 levels before Saddam
Hussein got surly and decided to rob his neighbors. The yellow
dashed line above represents the oil trend sans Gulf War. Even
AFTER the incredible rally that began in 1999, crude oil is STILL
only slightly above parity with real prices throughout most of the
1990s.

Of course, after
Saddam ran out of playground space for his war games and moved his
armored columns south into the appealing sandbox of Kuwait, oil
spiked dramatically, reaching prices in today’s dollars of far over
$50 per barrel. The trend from those real Gulf War oil highs to
current price levels is obviously down, marked by the red line.

Interestingly,
conditions today in crude oil are much like the early 1970s, with a
few tiny unresolved issues remaining between the Muslims and the
Jews. In 1973, the Islamic world was growing tired of Israel again,
and it had been six years since the last time it launched an
invasion to attempt to drive the Jews into the Mediterranean Sea in
the 1967 surprise attack. So the Muslims invaded again on the
holiest day of the Jewish year, Yom Kippur 1973. Miraculously, the
miniscule nation of Israel expelled the Soviet-equipped Muslim
hordes that attacked from Syria and Egypt, to the world’s
amazement. OPEC, consisting of almost exclusively Islamic nations,
was not happy at the loss in its ancient Jihad and the perceived
support of Israel by the West, so it cut oil supplies, the great
Arab Oil Embargo of the 1970s.

With OPEC still
controlling global oil production at the margin and hence global
prices, and finally getting its act together to cooperate again
today, do you think Islamic nations like Saudi Arabia, Iran, Iraq,
Libya, and Kuwait will sit by the wayside as the ages old
Islamic-Jewish conflict in Israel heats up yet again? Will there be
another Islamic oil embargo in the coming years to show solidarity
to their “Palestinian freedom fighter” brothers still trying to
destroy Israel? Another topic for another essay, but the key point
to realize is that oil is NOT expensive right now in real terms, but
it will be in a matter of weeks if there are any major supply
disruptions like a new Middle East war.

To review, we have
discussed the time-tested and fire-proven contrarian philosophy of
“buy low sell high”, analyzed the cyclical nature of the commodities
markets over the last 80 years, and zoomed in tactically to survey
the carnage and lows in individual commodities. The weight of
evidence strongly suggests commodities are cyclical, they are very
low in price, and they are due for a mega rally. Two final
questions remain… Why will commodities increase in price? And when
should commodities be sold to realize vast profits in the coming
bull?

Commodity prices
will be forced to rise initially by pure supply and demand
fundamentals. When a particular commodity price is low, as we
discussed above with natural gas, demand rises and supply dwindles.
Eventually, prices have to rise as production cannot keep up with
consumption demand. The initial rallies in the coming commodities
bull are likely to be mostly supply and demand based, such as the
rally from 1999 lows of the crude oil market.

After a few years
of supply and demand based rallies, speculative capital will once
again lust after commodities as it has so many times in human
history. At that stage in the coming commodities bull, commodity
price increases will begin to spiral up, faster and faster, as fresh
capital pours into the markets. Eventually, once most of the
professionals are in, the general conventional investing public will
see the commodity price gains and think “wow, that is the place to
be and we better invest”. By this time the commodity bull will be
in its late stages and nearing its ultimate bubble blow-off
parabolic phase.

When to sell the
coming great commodity bull of the 2000s? At that exact mania
stage. When all your neighbors are jumping into the “hot
commodities market”, and bubblevision plays commodity news 24 hours
a day, and financial magazines focus almost exclusively on
commodities, and the shoe-shine boy at the airport is telling you
about the next hot commodities stock IPO, that is when to “sell
high”. The commodities bubble top is probably 7-9 years away right
now, but there will be no mistaking it when we see it. Any thinking
investor who lived and traded through the NASDAQ bubble of 2000 will
never again wonder how to recognize a speculative mania bubble!

Bottom line? We
believe that the commodities market has a high probability of being
THE great destination for capital in the coming decade. Like all
bull markets, this coming commodities boom will began relatively
slowly. The first ones in will be the brave contrarians who
recognize true value in a market area that has been nuked and laid
to waste. Gradually, as the 00’s progress, the commodities bull
will gather more and more steam as more and more individual
commodities rally and reach new highs. Ultimately, speculative
capital will gravitate to the ever-increasing returns on
commodities, commodities equities, and commodities derivatives,
driving prices even higher. Finally, in the late stages of the bull
market, the casual conventional investor will desperately throw in
their lot, dumping massive amounts of capital into the markets that
will push commodity prices to red-hot parabolic extremes.

Enough money can
and will be made in the coming commodities bull to last a lifetime,
and those in early and out early (before the ultimate bubble
collapse) will likely be the new “Masters of the Universe” on Wall
Street in 2011.

Remember, all
market wisdom is distillable into four simple words, Buy Low Sell
High. Imagine knowing what we know now about tech stocks back in
1990, and having a chance to saddle-up and ride the 1990s tech bull
market from near trough to peak… We believe a similar
macro-contrarian buy opportunity exists TODAY in beaten-down
commodities.